Using 20th Century Technology in a 21st Century World: IRS Stops Initiating Contact By Phone on Failure to Deposit Cases

There was a great scene from the TV show Black-ish last season when the stylish and trendy older daughter Zoey (played by Yara Shahidi) decides she has had enough of her brothers’ using her trend-setting ways as a way to get ideas on the next big thing to make money in the stock market. She decides to thwart her brothers’ plans and shun new technology; we see her sitting in a chair reading a print newspaper and making a phone call on a rotary phone. (as an aside, video of this generation of kids trying to use a rotary phone is a good way to spend a few minutes).

The antithesis of successful integration of technology for communication is the IRS. When one looks at tax administration, we see a world where the IRS for the most part operates in a 20th century model. To be sure, IRS has achieved success in getting Americans to e-file (in partnership with the private sector), but as the recent Electronic Tax Administration Advisory Committee report indicated the IRS is “mired in a manual taxpayer service delivery model that relies on interactions using people, paper and phones.” The IRS needs to change the meet the expectations of those who expect to seamlessly communicate while at the same time be sensitive to the needs of those who rely on and may in fact prefer the opportunity for a more personal way to communicate with the IRS.

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The next few years will be important as the IRS tries to shift away from paper and phones and begin providing resources for real time communications with taxpayers (see NTA Objectives Report Focuses on IRS Future State: Some Thoughts on Technology, Participation and Tax Administration). This possible shift is one of the most important developments in tax administration. No doubt it has animated the National Taxpayer Advocate in her efforts to get the IRS to balance its needs for efficiency and the public’s expectation that it can communicate with its citizens in a manner similar to other business interactions with the realities that among other things there is a deep digital divide in our country. This complicates IRS measures to rely heavily on technology for all the programs it administers, especially those like refundable credits where many Americans who claim various credits do not have ready internet access.

One complicating feature that all businesses (and IRS) have come to address is the possibility that bad guys are out to get personal information that would facilitate identity theft and just plain theft. We have discussed identity theft and IRS imposter scams many times as well. In a speech earlier this year the Commissioner said that IRS would not initiate phone calls to taxpayers; that was a big deal because as TIGTA and others have reported there has been a proliferation of IRS imposter phone schemes that have separated many innocents from their money.

Well, it turned out that in some instances IRS did initiate phone calls with Americans. One area was when employers are delinquent with depositing employee income and employment taxes. IRS has been pulling back from that practice, and earlier this month in an IRS Small Business and Self-Employed Division (SB/SE) legal memorandum the Director of Collections Policy indicated that “[i]n response to the continuing threat of phone scams, phishing and identity theft, we are changing our practice of making initial contact on FTD (Failure to Deposit) Alerts by telephone.”

The memorandum provides some additional information, including some templates for letters to use and how the process should work generally:

Field contact is the preferred method of contact on assigned FTD Alerts. However, Revenue Officers retain the discretion to determine the best method of effective initial contact on a case-by-case basis. Effective immediately, all anticipated telephone initial contacts on FTD Alert taxpayers can proceed AFTER a notice is sent to the taxpayer informing them that a Revenue Officer (RO) will contact them by phone within 15- calendar days of receipt of the FTD Alert.

Parting Thoughts

It is not easy trying to administer compliance with FTD penalties, which require a real time interactive experience to prevent the possibility of cascading liabilities. It is even more difficult for an agency stuck in 20th century technology and at the same time combatting 21st century scams. I suspect in about ten years the way the IRS communicates with taxpayers in 2016 will remind us of Lily Tomlin playing Ernestine the telephone operator trying to collect an unpaid phone bill.

Summary Opinions through 12/18/15

Sorry for the technical difficulties over the last few days.   We are glad to be back up and running, and hopefully won’t have any other hosting issues in the near future.

December had a lot of really interesting tax procedure items, many of which we covered during the month, including the PATH bill.  Below is the first part of a two part Summary Opinions for December.  Included below are a recent case dealing with Section 6751(b)(1) written approval of penalties, a PLR dealing with increasing carryforward credits from closed years , an update on estate tax closing letters, reasonable cause with foundation taxes, an update on the required record doctrine, and various other interesting tax items.

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  • In December, PLR 201548006 was issued regarding whether an understated business credit for a closed year could be carried forward with the correct increased amounts for an open year.  The taxpayer was a partner in a partnership and shareholder in an s-corp.  The conclusion was that the corrected credit could be carried forward based on Mennuto v. Comm’r, 56 TC 910, which had allowed the Service to recalculate credits for a closed year to ascertain the correct tax in the open year.
  • IRS has issued web guidance regarding closing letters for estate tax returns, which can be found here.  This follows the IRS indicating that closing letters will only be issued upon taxpayer request (and then every taxpayer requesting a closing letter).  My understanding from other practitioners is that the transcript request in this situation has not worked well.  And, some states will not accept this as proof the Service is done with its audit.  Many also feel it is not sufficient to direct an executor to make distributions.  Seems as those most are planning on just requesting the letters.
  • Models and moms behaving badly (allegedly).  Bar Refaeli and her mother have been arrested for tax fraud in Israel.  The Israeli taxing authority claims that Bar told her accountant that she resided outside of Israel, while she was living in homes within the country under the names of relatives.  Not model behavior.
  • The best JT (sorry Mr. Timberlake and Jason T.), Jack Townsend, has a post on his Federal Tax Procedure Blog on the recent Brinkley v. Comm’r case out of the Fifth Circuit, which discusses the shift of the burden of proof under Section 7491.
  • PMTA 2015-019 was released providing the government’s position on two identity theft situations relating to validity of returns, and then sharing the return information to the victims.  The issues were:

1. Whether the Service can treat a filed Business Masterfile return as a nullity when the return is filed using a stolen EIN without the knowledge of the EIN’s owner.

2. Whether the Service can treat a filed BMF return as a nullity when the EIN used on the return was obtained by identifying the party with a stolen name and SSN…

4. Whether the Service may disclose information about a potentially fraudulent business or filing to the business that purportedly made the filing or to the individual who signed the return or is identified as the “responsible party” when the Service suspects the “responsible party” or business has no knowledge of the filing.

And the conclusions were:

1. The Service may treat a filed BMF return as a nullity when a return is filed using a stolen EIN without the permission or knowledge of the EIN’s owner because the return is not a valid return.

2. The Service may treat a filed BMF return as a nullity when the EJN used on the return was obtained by using a stolen name for Social Security Number for the business’s responsible person. The return is not a valid return.

  • Back in 2014, SCOTUS decided Clark v. Rameker, which held that inherited IRAs were not retirement accounts under the bankruptcy code, and therefore not exempt from creditors.  In Clark, the petitioners made the claim for exemption under Section 522(b)(3)(C) of the Bankruptcy Code for the inherited retirement account, and not the state statute (WI, where petitioner resided, allowed the debtor to select either the federal exemptions or the state exemptions).  End of story for those using federal exemptions, but some states allow selection like WI between state or federal exemptions, while others have completely opted out of the federal exemptions, such as Montana.  A recent Montana case somewhat follows Clark, but based on the different Montana statute.  In In Re: Golz, the Bankruptcy Court determined that a chapter 7 debtor’s inherited IRA was not exempt from creditors.  The Montana law states:

individual retirement accounts, as defined in 26 U.S.C. 408(a), to the extent of deductible contributions made before the suit resulting in judgment was filed and the earnings on those contributions, and Roth individual retirement accounts, as defined in 26 U.S.C. 408A, to the extent of qualified contributions made before the suit resulting in judgment was filed and the earnings on those contributions.

The BR Court, relying on a November decision of the MT Supreme Court, held that an inherited IRA did not qualify based on the definition under the referenced Code section of retirement account.  I believe opt-out states cannot restrict exemption of retirement accounts beyond what is found under Section 522, but it might be possible to expand the exemption (speculation on my part).   Here, the MT statute did not broaden the definition to include inherited IRAs.

  • In August, we covered US v. Chabot, where the 3rd Circuit agreed with all other circuits in holding the required records doctrine compels bank records to be provided over Fifth Amendment challenges.  SCOTUS has declined to review the Circuit Court decision.
  • PLR 201547007 is uncool (technical legal term).   The PLR includes a TAM, which concludes reasonable cause holdings for abatement of penalties are not precedent (and perhaps not persuasive) for abating the taxable expenditure tax on private foundations under Section 4945(a)(1).  The foundation in question had assistance from lawyers and accountants in all filing and administrative requirements, and those professionals knew all relevant facts and circumstances.  The foundation apparently failed to enter into a required written agreement with a donee, and may not have “exercised expenditures responsibly” with respect to the donee.  This caused a 5% tax to be imposed, which was paid, and a request for abatement due to reasonable cause was filed.  Arguments pointing to abatement of penalties (such as Section 6651 and 6656) for reasonable cause were made.  The Service did not find this persuasive, and makes a statutory argument against allowing reasonable cause which I did not find compelling.  The TAM indicates that the penalty sections state the penalty is imposed “unless it is shown that such failure is due to reasonable cause and not due to willful neglect.”  That language is also found regarding Section 4945(a)(2), but not (1), the first tier tax on the foundation.  That same language is found, however, under Section 4962(a), which allows for abatement if the event was due to reasonable cause and not to willful neglect, and such event was corrected within a reasonable period.  Service felt that Congress did not intend abatement to apply to (a)(1), or intended a different standard to apply, because reasonable cause language was included only in (a)(2).  I would note, however, that Section 4962 applies broadly to all first tier taxes, but does specify certain taxes that it does not apply to.  Congress clearly selected certain taxes for the section not to apply, and very easily could have included (a)(1) had it intended to do so.

I’m probably devoting too much time to this PLR/TAM, but it piqued my interest. The Service also stated that the trust cannot rely on the lack of advice to perform certain acts as advice that such acts are not necessary.  I am not sure how the taxpayer would know he or she was not receiving advice if it asked the professionals to ensure all distributions were proper and all filings handled.  I can hear the responses (perhaps from Keith) that this is a difficult question, and perhaps the lawyer or accountant should be responsible.  I understand, but have a hard time getting behind the notion that a taxpayer must sue someone over missed paperwork when the system is so convoluted.  Whew, I was blowing so hard, I almost fell off my soapbox.

  • This is more B.S. than the tax shelters Jack T. is always writing about.  TaxGirl has created her list of 100 top tax twitter accounts you must follow, which can be found here. Lots of great accounts that we follow from writers we love, but PT was not listed (hence the B.S.).  It stings twice as much, as we all live within 20 miles of TaxGirl, and we sometimes contribute to Forbes, where she is now a full time writer/editor.  Thankfully, Prof. Andy Gerwal appears to be starting a twitter war against TaxGirl (or against CPAs because Kelly included so many CPAs and so few tax professors).  We have to throw our considerable backing and resources behind Andy, in what we assume will be a brutal, rude, explicit, scorched earth march to twitter supremacy.  We are excited about our first twitter feud, even if @TaxGirl doesn’t realize we are in one.
  • This doesn’t directly relate to tax procedure or policy, but it could be viewed as impacting it, and we reserved the right to write about whatever we want.  Here is a blog post on the NYT Upshot blog on how we perceive the economy, how we delude ourselves to reinforce our political allegiances (sort of like confirmation bias), and how money can change that all.

Former TAS Employee Implicated in ID Theft Refund Scheme

There are bad seeds in any organization, and IRS is not exempt from that. Despite that reality, the news release that the Northern District of Alabama US Attorney’s office issued the other day is particularly disturbing because it highlights how one of the IRS’s own allegedly was involved in using her position at the Taxpayer Advocate Service to steal taxpayer identities and use that knowledge to facilitate the receipt of over a million dollars in bogus refunds.

The US Attorney’s Office announced that it indicted former TAS employee Nakeisha Hall and co-conspirators for  “their involvement in a 2008 to 2011 scheme operated out of Birmingham that involved stealing personal identity information from the Internal Revenue Service to create fraudulent tax returns and collecting the stolen refunds.”

We have written a few times about the scourge of identity theft in the past year, with excellent guest posts on the topic from former prosecutor Justin Gelfand and practitioner Rachael Rubenstein. This story, however, is particularly disturbing because Hall abused her position of trust in a way that can seriously undermine confidence in the tax system, and in particular given her position at TAS, which has a major role in helping taxpayers resolve identity theft issues.

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The news release expands on that:

Taxpayers trust, and expect, that IRS employees, as a whole, will safeguard their most sensitive personal information. Taxpayers also must trust that IRS employees in the Taxpayer Advocate Service will not only protect their sensitive information but will actively assist them when it has been compromised by others,” [US Attorney] Vance said. “An IRS taxpayer advocate who exploits that trust, and with full knowledge of the significant impacts of identity theft, uses her IRS access to compromise taxpayers’ identities and steal a million dollars from the U.S. Treasury is committing a particularly egregious crime that will not go unpunished,”  Vance said.

The release detailed the scheme:

Hall obtained individuals’ names, birth dates and Social Security numbers through unauthorized access to IRS computers. Hall used the personal identity information to prepare fraudulent income tax returns and submitted them electronically to the IRS. Hall requested that the IRS pay the refunds onto debit cards and directed that the cards be mailed to drop addresses that she controlled. Hall solicited and received drop addresses from Goodman, Coleman and other co-conspirators, who also collected the refund cards from the mail.

Hall activated the cards by using stolen identity information. She, Goodman, Coleman and other co-conspirators took the money off the debit cards at ATMs or used the cards for purchases. If the fraudulent returns generated U.S. Treasury checks rather than the requested debit cards, Hall and her co-conspirators used fraudulent endorsements in order to cash the checks. Hall compensated Goodman, Coleman and other co-conspirators by giving them a portion of the refund money, or by giving them refund cards for their own use.

Parting Thoughts

No doubt the misdeeds of an IRS employee will draw much attention, and it should. As the US Attorney notes, it is particularly egregious when someone in a position of trust violates that trust. That has an impact not only on the public, but also on the morale of the many IRS employees that day in and day out try their best to help the public.

Identity theft is a major problem that exists independent of misdeeds of a rogue IRS employee. TAS on an individual case level and on a systemic level has been and continues to be a major force for good. For example, in reports and in testimony the National Taxpayer Advocate has detailed IRS’s administrative process errors and recommended “Congress establish a timeframe for the IRS to develop a strategy and timeline for accelerating third-party information report processing and providing taxpayers with electronic access to such data.” 2105 Testimony Before the House Committee on Oversight and Government Reform.

Recent PATH legislation accelerates the timeframe for the filing of information returns and mandates a delay in the payment of refunds attributable to refundable credits, actions consistent with those recommendations and reflective of how TAS continues to be a positive force in identifying problems and proposing solutions to tax administration problems.

There is still much to do in this area. This story is depressing and to the extent there are other problems within IRS and TAS one hopes that TIGTA and prosecutors chase down all of the bad actors. The problem though goes well beyond the bad actors, and Congress and IRS still have their hands full as we enter a new filing and identity theft season as well.

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8:35 AM 12/31: Note: The story was updated to reflect that the indicted person is a former TAS employee

 

IRS Announces Procedures for Identity Theft Victims to Request Copies of Fraudulently Filed Tax Returns

Today we welcome back guest blogger Rachael E. Rubenstein who recently joined Strasburger Attorneys at Law in San Antonio, Texas after serving as the director of the low income taxpayer clinic at St. Mary’s law school. Rachael was a principal author of the Identity Theft chapter in the 6th Edition of Effectively Representing Your Client Before the IRS.  She writes today about the recent change in IRS policy that will allow victims of identity theft to see a redacted version of the return filed by the thief using the victim’s tax identifying information.  This is a much needed change that has been a long time coming.  Keith

On November 5, 2015, the Service announced instructions and information for taxpayers to request copies of fraudulent returns filed by identity thieves using their personal information.

For several years, victims and advocates (including TAS representatives, LITC clinicians, and private practitioners) have pushed for access to these returns. However, until last week, the Service did not permit its employees to provide victims of identity theft copies of tax returns filed under their SSNs due to concerns about section 6103 disclosure violations, despite clear guidance on the topic in 2012 from Chief Counsel. In May of this year, Senator Ayotte pressed Commissioner Koskinen on this issue. He responded with a letter stating that the Service decided to change its policy regarding disclosure of fraudulent returns and would develop procedures to enable victims to request and receive copies of these returns. In August, during a congressional hearing on Tax Related Identity Theft and Fraudulent Tax Returns, representatives from TAS and TIGTA specifically testified about this policy change and their desire for the Service to move forward with its plans to grant access to fraudulent returns. Although this news was long-awaited, the Service delivered on the Commissioner’s pledge.

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The announcement states that copies of the current tax year and the previous six years are available. The instructions are fairly specific in terms of what a taxpayer, or authorized representative, must include along with the request. A chart covers what return information will be visible on the copy versus redacted. For example, the names of the taxpayer, spouse, and any dependents on the return will be redacted except for the first four letters of the last name. SSNs, ITINs, and EINs will also be redacted except for the last four digits. Additionally, phone numbers and bank numbers will be redacted expect for the last four digits. The entire address will be redacted minus the street name. The names and addresses of “other persons” or entities listed on the return will be completely redacted along with the numbers associated with the tax return preparer or third party designee.

The redactions appear appropriate in light of the disclosure statute and Chief Counsel guidance, although, arguably, the restrictions may go further than required under section 6103 with respect to “other persons,” namely return preparers. The instructions indicate that a request will be returned if the address listed does not match the requestor’s IRS address of record. There are certainly instances when a victim’s IRS address of record is changed due to no fault of his own. For example, the address of record may not be correct when the Service processes an identity theft return and does not receive a paper filed return from the true owner of the SSN for the same tax year. Taxpayers whose requests are rejected due to an address mismatch will be instructed to change their address of record by filing a Form 8822, Change of Address. The request may be resubmitted after the Service processes the address change.

During the initial phase of this new program, the Service will probably take longer than the reported 90 day average to effectively process and respond to requests for copies of fraudulent returns, as the volume is unpredictable and the cases complex. Undoubtedly many requestors will experience processing holds due to open identity theft issues, and a significant number of requests will likely be returned as a result of address mismatches or failure to follow the instructions. Nonetheless, in an era of perceived dysfunction in tax administration, it’s important to acknowledge when a positive policy change occurs through multifaceted advocacy efforts.

Proposed Legislation to Combat Identity Theft and Override Loving

We have written extensively on the separate but at times related issues of identity theft and refund fraud. Last week, for example, guest poster Rachael Rubenstein wrote an update on identity theft issues; the post generated spirited comments including one by Bob Kamman essentially suggesting that lots of the blame lies with Congress and the administrations for failing to step up and provide the means necessary for the IRS to step into the 21st century, unlike Bob’s example of  tax administration powerhouse Estonia. Senate Finance staffers gobbling up our posts and comments have sprung to action, with the Senate Finance Committee scheduling an open executive session tomorrow at 10 AM to mark up a bill designed to “prevent identity theft and refund fraud.”  (link to the session is here)

My ear is not to the DC ground but the bill has the bipartisan support of the Chair, Senator Hatch, and ranking Democrat Senator Wyden. A press release announcing the mark up is here; a description of the Chair’s mark up can be found here, and a summary can be found here.

Some of the key proposals in the legislation include requiring the IRS to reduce burdens on identity theft victims. The IRS would also be required to consider and report on measures it is taking to detect and combat identity theft and also study the possibility of allowing someone to file an affidavit blocking the e-filing of returns.

I have previously discussed how thieves take advantage of the IRS look-back compliance model and how earlier matching of information returns before issuing refunds is a crucial measure that can give the Service the means to stop the outflow of funds through identifying discrepancies. Importantly, the legislation includes a number of measures to give the IRS the power to move away from that model. For example, it would push up the filing of W-2, W-3 and 1099 MISC to 15 days after the due date for payee statements, as well as require the IRS to study the possibility of moving up deadline for other information returns. The bill also facilitates the means to get the IRS off its look-back model through requiring many small businesses to transition from paper W-2 and 1099 filing to e-filing and mandates that e-prepared returns that are paper filed have a scannable code allowing the IRS to process the return information more efficiently. Moreover, as the summary describes, the bill allows the IRS to access data in the National Directory of New Hires “for the sole purpose of identifying and preventing false or fraudulent tax return filings and claims for refund.”

There is more in here too, including an increase in penalties on preparers who improperly use taxpayer information and an override of Loving by giving Treasury authority regulate all aspects of tax practice, including paid tax return preparers. It also gives IRS the authority to revoke PTINs of preparers.

This legislation has the potential to be a game changer for tax administration. While the passage of the legislation is unlikely to be a walk in Lahemma perhaps the confluence of high profile cyber thefts and apparent bipartisan support will begin to tip the scales away from those who view the tax system as an open cookie jar.

 

 

 

 

 

Summer Updates: Identity Theft and Tax Administration

Today, we welcome back guest blogger, Rachael E. Rubenstein.  Rachael served as the principal author in the Identity Theft chapter in the recently published 6th Edition of Effectively Representing Your Client before the IRS.  So much has been happening in this area recently that we asked Rachael to bring us up to date and she has done so with a comprehensive post on this area over the past few months.  Rachael just moved from a teaching position at St. Mary’s Law School in San Antonio, Texas where she directed the low income taxpayer clinic to the firm of Strasburger & Price, LLP in the same city.  We appreciate her willingness to write extensively while in the midst of a practice move.  Keith

Tax-related identity theft was a hot topic this summer.  Since I last blogged about it in May, the NTA released her Fiscal Year 2016 Objectives Report to Congress, alerting us to an upswing in the number of open identity theft cases in IRS inventory; a written report was released containing details of the 2015 Security Summit held by Commissioner Koskinen; Senators Johnson, Warner, and Ayotte introduced the Social Security Identity Defense Act of 2015; and the Senate Budget Committee held a hearing, convened by Senator Ayotte, on Tax-Related Identity Theft and Fraudulent Returns.

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My previous post optimistically noted that after almost a decade of annual increases, the volume of IRS identity theft incidents finally declined by roughly 42 percent in 2014 compared to its peak of 1,901,105 in 2013. Considering the attention and resources focused on this problem, the marked decline in 2014 showed promise.  Unfortunately, the NTA’s June report indicates that the number of open identity theft cases impacting taxpayers in IRS inventory (as of May 2015) swelled again to near May 2013 levels—up 69 percent from May 2014.

The NTA attributes the recent rise in open identity theft cases back to levels observed in 2013 to “the overreach of the TPP [Taxpayer Protection Program] filters and understaffing of the TPP phone lines.” The TPP is responsible for detection, evaluation, and prevention of improper refunds related to identity theft. During the 2015 filing season, TPP return processing filters identified 1,558,874 potentially fraudulent returns using 196 distinct filters that flag returns when certain characteristics are identified. The false positive rate was around 34 percent, meaning that a third of electronically filed tax returns that TPP stopped from posting to a particular account were filed by legitimate taxpayers who expected timely receipt of their tax refunds. These taxpayers received a TPP notice instructing them to call a particular phone number to resolve the issue; however, most that called during the peak of tax season in February were unable to get through at all to a live phone assistor. For those that did get through, there average wait time was between 20 minutes to over an hour.

Immediately after the May 2015 data breach scandal (which turned out to affect around 250,000 more taxpayers than initially reported), we learned that earlier in the Spring, Commissioner Koskinen convened key officials from state taxing authorities and the private tax industry together for a Security Summit to discuss the significant challenges facing tax administration as a result of tax-related identity theft, and potential coordinated strategies. It was widely reported that an agreement was reached among the participants “to form a public-private partnership committed to protecting the nation’s taxpayers and the tax system from IDT [identity theft] refund fraud.” In June, a 9 page report was released detailing the goals of each of the working groups formed from the Security Summit, outlining recommendations, listing existing proposals for congressional consideration, discussing next steps, and describing the participants. This partnership is certainly an innovative approach, and it will be interesting to see how this collaboration plays out.

The Social Security Identity Defense Act was introduced in May and is aimed at amending section 6103 to make it easier for victims of identity theft and law enforcement officials to receive information pertaining to tax-related incidents of identity theft from the FBI and DOJ. Although it is unlikely to be enacted, this bill has reignited discussion regarding the intersection of identity theft and section 6103 disclosure issues. For example—to what extent is the victim taxpayer entitled to information from the Service regarding the incident? Presently, under PMTA 2012-005, Chief Counsel takes the position that once an invalid return is submitted, it becomes the return information of both the true owner of the SSN and the identity thief because the information relates to the potential investigation of liability with respect to both parties. Therefore, the victim of identity theft should have a right to a copy of the bad tax return as long as disclosure would not impair federal tax administration.

In confirmed or suspected cases of identity theft, a taxpayer’s account is marked with various types of identity theft indictors. When such an indicator is present, taxpayers and their representatives may find it difficult to obtain copies of tax returns or related tax transcripts from the Service because employees are trained to safeguard taxpayer information protected by section 6103. Disclosure violations carry the threat of civil fines and even potential criminal charges. Despite Chief Counsel guidance indicting that the bad return is the return information of both the victim and the alleged identity thief, the IRM “instructs employees to not  to provide . . . copies of tax returns when identity theft indicators are present on the requestor’s account.” In May of 2015, Senator Ayotte wrote a letter to Commissioner Koskinen expressing her concern “with IRS’s refusal to provide tax identity theft victims with copies of the fraudulent returns filed in their names.” She referenced the 2012 Chief Counsel memorandum to support her complaint and request for the Service to change its non-disclosure practices. Commissioner Koskinen acquiescence in a written response issued later the same month and stated that the Service would develop procedures to allow victims of identity theft to request and receive (redacted) copies of tax returns filed under their SSNs.

The hearing held in August covered familiar and fairly bleak territory as well as some encouraging announcements about major programmatic changes regarding identity theft cases processing. A taxpayer testified about the bureaucratic nightmare she endured dealing with IRS and other agencies when her e-filed return was rejected because her deceased child’s SSN was used to file multiple fraudulent returns (it is worth noting that none of the fraudulent filings actually got passed IRS filters). Christopher Lee, TAS Senior Attorney Advisor; J. Russel George, TIGTA; and Commissioner Koskinen testified about the general state of refund-related identity theft—the broad consensus was that despite its many gains in terms of detection and prevention of refund-related identity theft, the Service still has a long way to go in order to get ahead of the overall identity theft crisis.

In addition to the jump in the number of incidents during the 2015 filing season, and the TPP false positive rate, lengthy delays in case processing and poor customer service are stubborn problems (although the situation is certainly not as bad as it once was in the early part of the decade). A study conducted by TAS of cases closed in 2014 found that 179 days was the average resolution time for an identity theft case from a taxpayer’s perspective. The Service’s slow progress towards improvement of case processing times is partly attributable to the increasing complexity of identity theft cases. Such cases require the involvement of multiple functions under the Service’s decentralized case management structure, which has been in operation for several years. The same 2014 TAS study found that approximately 30 percent of cases involve multiple issues.

TAS has repeatedly called for the Service to set-up “a sole point of contact system” for victims with complex identity theft cases. While the Service has announced its final phase of a plan to re-engineer its approach to victim assistance, moving towards a more centralized model, the prospects for adoption of this particular TAS recommendation appear dim. Commissioner Koskinen’s version of a “single point of contact” described during the hearing involves yet another specialized toll free phone line, as opposed to the TAS model of one designated employee to handle a particular victim’s case.

The Commissioner’s testimony reminded stakeholders that sophisticated cyber criminals present momentous challenges to the Service in an era of archaic IRS technological systems and strained financial resources. Still, he pledged that the Service is continuing to work diligently on efforts to combat identity theft, and he announced some specific plans for 2015-2016. One is the roll out of the Identity Theft Assistance organization, a consolidation of various identity theft programs into one division aimed at unifying the Service’s victim assistance and identity theft compliance activities. Another is an improved case resolution average of 120 days. Further, new protections for electronic filing, developed by the Security Summit working groups, were promised before the 2016 filing season.

The Service requested additional money for improved cyber security and revamped identity theft initiatives, which is reflected in the President’s FY 2016 Budget pending before congress. All tax administrators who testified at the hearing agree that the IRS needs more funding to address the identity theft epidemic. They also share the view that congress should take a more active role in enacting various legislative tools to assist the IRS in combating this pervasive problem.

 

 

Summary Opinions for the second half of May

Here is part two of the items from May we didn’t otherwise cover.  We’ll have the June items shortly, and then July.  Hopefully, I’ll get back on track for weekly summaries in the near future.

  • The Sixth Circuit in Ednacot v. Mesa Medical Group, PLLC affirmed the lower court tossing a physician assistant’s claim that an employer wrongfully withheld employment taxes.  The Court determined this was tantamount to a refund suit, which required the taxpayer to first file an administrative claim for refund with the IRS prior to bringing suit.  There seems to be a lengthy past between the parties in this case.  The petitioner brought up a valid seeming point that she did not know if the withholdings were paid to the IRS, and therefore wasn’t sure if the refund was appropriate, but the Court held that Section 7422 was designed to funnel these issues through the administrative process.
  • Couple interesting privilege cases recently, including the Pacific Management Group decision blogged by Joni Larson for us.  In a case that may have a somewhat chilling effect on making reasonable cause claims, the Tax Court has held that claiming reasonable cause to the substantial valuation misstatement penalty waived attorney client privilege and the work product doctrine for certain communications between the taxpayer and its lawyer and accountant.  See Eaton Corp. and Sub. v. Comm’r.  This holding was the affirming of a motion for reconsideration.  The Court found that although there was an objective determination under Section 6662(e)(3), whether relying on the advice on Section 482 was based on the facts and circumstances, including the advice of the lawyer.  By claiming reasonable cause, the privileges were waived for that issue.
  • Taxpayer was successful arguing against the substantial understatement penalty in Johnston v. Comm’r, but it was because the taxpayer didn’t actually owe the tax.  The IRS had argued that a debt between the taxpayer (an executive of a telcom company) and his company was discharged by his employer when he moved to a related entity.  There was credible evidence that it was not discharged and payment continued.  There was the pesky issue that the loan wasn’t paid until the IRS audited the individual, but the Court found that the audit prompted the company to do something with the loan and it hadn’t been tax avoidance…must have been persuasive testimony.
  • LAFA issued guidance on the effect on the limitations period on assessment for payroll tax when the wrong form is filed. (LAFA 20152101F).  Employers are generally required to file quarterly returns on Form 941 for employment taxes when they are paid in that period.  A different form, Form 944 is used for certain employers with little  employment tax liability, and that is required annually.  The statute generally runs from the date of the deemed filing of employment tax returns, which is April 15 the following year.  See Section 6501(a)&(b).  The LAFA reviews the following three situations:
  1. Employer is required to file Form 944, but instead timely files four quarterly Forms 941.

  2. Employer is required to file Form 944, but timely files Form 941 for the first and second quarters of the year instead, and files nothing for the third or fourth quarters of the year.

  3. Employer is required to file quarterly Forms 941, but timely files annual Form 944 instead.

 

The quick conclusions were:

  1.  Assuming the Forms 941 purport to be returns, are an honest and reasonable attempt to satisfy the filing requirements, are signed under penalty of perjury, and can be used to determine Employer’s annual FICA and income tax withholding tax liability, the Forms 941 meet the Beard formulation and should be treated as valid returns for purposes of starting the period of limitations on assessment.

  2.  An argument can be made that the Forms 941 for the first and second quarters of the tax year constitute valid returns under the Beard formulation since they purport to be returns and are signed under penalty of perjury. However, given that Employer’s FICA and income tax withholding tax liability for the third and fourth quarters will not necessarily be equal to that reported for the first two quarters, the Forms 941 arguably are not sufficient for purposes of the determining Employer’s annual FICA and income tax withholding tax liability and may not be honest and reasonable attempts to satisfy the tax law.

  3.  Assuming the Form 944 purports to be a return, is an honest and reasonable attempt to satisfy the filing requirements, can be used to determine Employer’s annual FICA and income tax withholding tax liability, and is signed under penalty of perjury, Employer’s Form 944 meets the Beard formulation and should be treated as a valid return for purposes of the period of limitations on assessment.

  • A taxpayer in a chapter 11 case, Francisco Rodriquez (not the current Brewers closer who pitched for the Mets before choking out his relative in the clubhouse) was successful in avoiding a lien under 11 USC 506 on property held by the taxpayer that was already underwater with three prior liens.  In re Rodriguez, 115 AFTR2d 2015-1750 (Bktcy D MD 2015).  Section 506 allows liens to be stripped if the property lacks equity, which was what the taxpayer was attempting.  SCOTUS in Dewsnup v. Timm held that  a chapter 7 debtor cannot “strip down” an allowed secured claim (clearly, I was not the debtor, otherwise SCOTUS would have tossed on some Its Raining Men, and granted my right to strip down—I only did it to pay for college, I swear—and yet, still so many student loans).  Various other cases have held that Dewnsup does not extend to other chapters in bankruptcy, and the District Court held that lien stripping was appropriate in chapter 11 under the taxpayer’s circumstances.
  • The Tenth Circuit continues its clear prejudice and hatred towards Canadians (I completely made that up and that link is NSFW) in Mabbett v. Comm’r, where it found the Tax Court properly tossed a petition as being untimely that was filed by a resident of the US, who was a Canadian citizen.  The Court found the Service had properly sent the stat notice to the taxpayer at her last known address (and even if that was not the case, her representative had forwarded her a copy well before the due date of the petition).  The taxpayer also claimed that she was entitled to the 150 day period to file her petition to the court under Section 6213(a) because she was a Canadian citizen.  The Court stated, however, that the statute was clear that the 150 day rule only applies when “the notice is addressed to a person outside the United States.”  The taxpayer had been traveling, and was Canadian, but failed to show she was outside of the United States at the time the notice was sent.
  • In case you haven’t seen, the Service has started a cybercrimes unit to combat stolen ID tax fraud.  In my mind, this is sort of like the IRS and Tron having a lovechild, which I would assume to look like this.  Jack Townsend has real coverage on his Federal Tax Crimes Blog.
  • Jack also has coverage of the new IRS FBAR penalty guidance, which can be found here

 

Reflections on the General State of Tax-related Identity Theft

We have previously discussed the challenges of identity theft in Procedurally Taxing, most recently in a guest post from former prosecutor Justine Gelfand. Today we return to the issue and welcome back guest blogger, Rachael Rubenstein, who is a Senior Tax Fellow at St. Mary’s School of LawRachael served as the principal author of the Identity Theft chapter in the 6th Edition of Effectively Representing Your Client before the IRS.”  Because of all of the changes in this area since the time of publishing the 5th Edition, she essentially had to write the chapter from scratch. She reflects here on recent issues concerning identity theft.  Her closing paragraph comparing the amount the IRS spends on data security compared to a large bank should give us all pause.  Keith

Recent news of a large scale data breach involving the IRS website here  here and here, and the announcement that the IRS plans to establish formal guidelines to allow victims of refund-related identity theft to gain access to copies of the fraudulently filed returns here, has refocused attention to the widespread issue of tax-related identity theft. As have reports during the filing season of suspicious tax return filings through TurboTax Software, which launched an ongoing FBI investigation here and  here. Coverage of this issue has inspired increased frustration and anger towards the IRS, an agency we all know is suffering from some serious PR problems. Last month my dad contacted me panicked because he learned a fraudulent tax return was filed under his Social Security Number (SSN). I told him what I tell many of my clients, “It will be ok. The problem will be fixed as long as you file the correct paperwork. The IRS has a lot of experience with this type of activity, although it will take several months to correct.”  Luckily my parents, unlike most clients, were not waiting on a large tax refund to supplement their income for the year. Still, the psychological and financial effects of this type of victimization are felt regardless of one’s tax bracket.

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In terms of tax administration, identity theft is a relatively new phenomenon—emerging in the early 2000s along with the rise in e-filing. There are two types of tax-related identity theft: refund-related and employment-related. The latter occurs when an individual uses the SSN of another in order to gain employment, which often causes IRS problems because of the wages earned and reported by employers under the wrong SSN.  Most attention and resources are focused on refund-related, which involves the use of stolen personal data to obtain improper refunds causing economic damage to individual taxpayers and the treasury. IRS figures estimate the cost of undetected refund-related identity theft at approximately $5 billion a year. Until tax year 2013, the numbers of taxpayers affected by (broadly defined) tax-related identity theft each year rose at an alarming rate. According to a 2013 TIGTA report here in calendar year 2010, there were roughly 440,581 IRS identity theft incidents compared to 1,901,105 in 2013.

From 2004 to 2013, the NTA identified tax-related identity theft as one of the “‘Most Serious Problems” faced by taxpayers in nearly every annual report submitted to Congress here. In addition to the various audits TIGTA conducts each year on the Service’s information security programs, TIGTA has aggressively audited IRS handling of identity theft and its ongoing efforts to stop it before a taxpayer is victimized. At the beginning of the decade refund-related identity theft overwhelmed the IRS. Victim taxpayers generally waited over a year to receive their refunds and, often, had to submit numerous copies of the same evidence to IRS in order to resolve their cases. A review of TIGTA and TAS reports shows that the peak of lost revenue and the length of case processing for victims occurred in 2010 through 2012. The volume of actual incidents (both employment and refund-related) was the highest in 2013 and, finally, declined by roughly 42% by the end of 2014 here. Since 2012, the IRS has made combating identity theft a top priority and steady progress has been made on both prevention and victim services. The IRS used a variety of methods to attack the problem, including: novel technology detection and prevention models,  increased criminal investigations/prosecutions, increased cooperation with the private sector, redevelopment of case processing procedures, expansion of programs to assist victims, and added personnel dedicated to handling identity theft cases. In April 2015, the most recent TIGTA audit on refund-related identity theft here reported $22–24 billion of fraudulent tax refunds were prevented during the 2013 filing season. Still, around $5.75 billion was lost as a result of this crime during the same period. These figures are based on IRS estimates, which generally capture higher figures than TIGTA audits. Most practitioners who regularly work these cases will tell you that processing times have improved (down to a not so impressive average of 6–8 months), and IRS employees are better equipped to handle identity theft claims. The darkest days of tax-related may have already passed, although vulnerabilities in IRS information technology programs could certainly turn the tide.

May’s data breach represented a shift in sophistication by identity thieves. Instead of using personal data stolen from external sources to steal refund money by e-filing fraudulent tax returns, hackers used a hybrid theft model. First, previously stolen information such as names, dates of birth, and addresses, were used to access the “Get a Transcript” feature on the IRS website. This tool was launched in January of 2014 to streamline taxpayer requests for prior year tax transcripts—reducing IRS call volume and providing instant data to the requestor. By accessing these transcripts, cyber-attackers obtained specific details about their victims filing histories. Such information was used (or planned to be used) to circumvent the Service’s return processing identity theft detection filters. It’s worth noting that the IRS has approximately 144 such filters. In his June 2nd testimony before the Senate Finance Committee on this incident here, Commissioner Koskinen stated the Service’s cyber security team detected suspicious activity on the “Get a Transcript” application in mid-May and shut down the feature on May 21st. IRS investigation revealed that roughly 100,000 taxpayer accounts were affected, resulting in around 13,000 suspect tax returns filed. About $39 million in fraudulent refunds were paid out. Another 23,500 returns from these compromised accounts were stopped by IRS fraud filters.

Shifting blame to the IRS for this cyber attack is easy. Much of the agency’s information technology systems are antiquated and known vulnerabilities continue to exist (detailed in TIGTA’s June 2nd written testimony here). Any time there is a high profile problem identified in tax administration, we hear a familiar parade of horribles launched at the agency. This massive disclosure violation merits a more thoughtful response. Indeed, last week IRS announced a formal agreement to work collaboratively with state tax administrators and leaders of the private electronic tax industry. Details of the agreement were developed after Koskinen convened a Security Summit with IRS representatives and these external stakeholders on March 19th, and include new initiatives in the areas of taxpayer authentication; fraud identification; information sharing/assessment; cybersecurity framework; and taxpayer awareness and communication here. These coordinated efforts sound promising but there is a missing player in this partnership to fight back against tax-related identity theft.

Since 2011, at least a dozen congressional hearings on this topic were held, yet no meaningful legislation has emerged to combat tax-related identity theft. The well-treaded path of investigation, condemnation, cost cutting, and added responsibilities will not suffice—legislative solutions are needed. Koskinen mentioned several in the June 2nd hearing: approval of the President’s FY 2016 Budget request (“with $101 million specifically devoted to identity theft and refund fraud, plus $188 million for critical information technology infrastructure”); passage of legislation to “accelerate information return filing deadlines” for improved detection of fraudulent filings during tax season; and criminal and civil penalty deterrence statutes. On June 4th, Senate Finance Committee Chairman, Orrin Hatch, and Ranking Member, Ron Wyden, released a statement outlining the Committee’s work on this issue here. Legislation introduced by Senator Marco Rubio in March of 2015 here aimed at curtailing tax-related identity theft may also merit consideration. Lawmakers should act to implement legislation and better safeguard the public fisc from this pervasive crime.

*In 2014, JP Morgan Chase spent $250 million on cyber security and still experienced a large scale data breach here. In comparison, the IRS spent around $141.5 million on cyber security in the same year here.